(BP stock analysis article updated for details on BP lawsuits against Cameron, Transocean, Halliburton)
As the analysts note, it's going to be a good first quarter -- and potentially very good year -- for BP as long as oil prices don't collapse. So what can BP do with its bulging wallet, flush with cash yet with the oil spill liability overhang still in effect, that could serve as a positive catalyst for shares? Oppenheimer's Gheit estimates that with every $1 change in the price of oil, BP makes $350 million, and with the recent run up in oil prices, BP just made an additional $7 billion to $8 billion in unexpected profits. The two main financial incentives that analysts are debating are a reinstatement of a share-buyback program by BP -- for the first time since 2008 -- and the potential for BP to hike its dividend back to the generous rate it paid investors before the oil spill. Raymond James' Molchanov said share buybacks would be a great catalyst for BP. "It doesn't take much to get a stock moving when it's trading at a really remarkably low multiple of 6.5 times current year earnings," the analyst argued. ExxonMobil is known as the "serial" stock repurchase among the integrated oil companies, while BP has historically been more balanced between its cash deployment for share buybacks and for its dividend. Raymond James' Molchanov noted that the BP dividend was suspended as a direct result of the oil spill -- it was reinstated in the past quarter at half the rate, or 42 cents per ADR share. On the other hand, the BP stock buyback program was suspended well before the oil spill. The Raymond James analyst doesn't view the potential for a share buyback as a distant dream with triple-digit oil prices. Raymond James estimates that BP will generate $33 billion in cash flow with oil above $100, and that is after paying the $4 billion cost of the spills claim fund. BP's spending budget is $20 billion, so subtracting the spill fund and spending from $33 billion indicates that BP still has $13 billion in free cash flow. The recently reinstated BP dividend amounts to $5 billion annually, meaning that above and beyond the current dividend BP has $7.5 billion of free cash. Molchanov added that this cash flow figure could be low given that it's not including the $6 billion to $7 billion in asset sales BP still has said it will make, as well as more immediately, the proceeds from asset sales already announced but not yet closed. Molchanov notes that $7.5 billion of free cash flow "is a lot of money and available for buybacks. I'm not saying BP will resume the buybacks immediately, and there are political reasons for holding off, but I think BP is in a good financial position to repurchase shares." Oppenheimer's Gheit agreed, and prefers that BP resume share buybacks as opposed to increasing the dividend to its pre-spill level. "If there was something good about the oil spill, it's that the dividend was not maintainable at that level. The problem was internationally based oil companies like BP and Shell raising dividends because they succumbed to investors and analysts in Europe pushing for ever higher dividends," the analyst explained, adding that it would require $150 crude oil prices for these companies to be justified to go back to the level of dividend increase that they offered in the recent past. "The new reality of the BP dividend is where it is today, but if they can settle litigation in the next year, a share-buyback program could be a possibility," the Oppenheimer analyst said.
From the perspective of Argus Research analyst Phil Weiss, the sudden financial strength of BP is a plus, but a share repurchase wouldn't be his choice as a catalyst for BP shares. Weiss noted that BP lowered its debt as it has increased cash and the company wants to have financial flexibility given the oil spill liability overhang. The Argus Research analyst thinks the wisest use of a BP flush with cash is accelerated spending in exploration projects, especially if the Rosneft deal falls apart. Considering BP the cash cow and Argus Research analyst Weiss' comments about pouring cash into exploration leads directly to the recent asset divestitures made by BP. In the same way that Oppenheimer's Gheit argues the oil spill had the unintended, and good, consequence of forcing the BP dividend down, analysts believe that the oil spill pushed BP to sell off non-core assets quicker than it might have otherwise done, especially in the case of some specific asset sales that should have been made all along. "These large oil companies should be looking to sell off those assets they can't devote attention to, or put capital into, which are worth more in the hands of someone else," said Argus Research's Weiss. "There are so many other more lucrative projects, and it's better to monetize assets through regular asset divestitures. BP wasn't as aggressive as it could have been in selling assets before the oil spill," Weiss concluded. While BP was forced to sell, the so-called "fire sale" never occurred, says Oppenheimer's Gheit. In fact, BP was fortunate that it was a buying market and many wanted to make bids on its assets. "The seller got a fair price in my view and as a result BP is sitting on $24 billion in cash from sales with $6 billion more to go," the analyst said. "This company is not liquidating. This company is selling assets it believes to be much more valuable to others and BP wants to grow the company from a smaller and stronger base, with more financial flexibility," Gheit concluded. Raymond James analyst Molchanov added that the assets BP sold were generally low margin or low growth assets in places like Argentina, Vietnam and Pakistan. "The oil spill compressed the sales in a short period of time, and in that sense the oil spill was a catalyst to help BP take stock of its portfolio and re-conceptualize it. BP ends up with a high margin asset base," the analyst said. Indeed, the sudden cash bulge at BP raises the issue of whether BP's new management team led by CEO Bob Dudley can effectively deploy the cash. "More cash flow presents the opportunity to take capital and put it to good use -- and, on the other hand, the risk that the cash is mismanaged," Molchanov said. With earnings coming up on April 27, a big question for BP is what it does with the surplus cash flow that it didn't budget for, whether it's increasing the dividend, stock buybacks or increasing the spending budget. "The management responsibility here is to provide clarity on BP spending priorities," Molchanov said.
When BP first announced its Arctic venture with Rosneft on Jan. 14, its shares gained $1.75 and reached their year-to-date high near the $50 mark. Yet since the negative headlines and Rosneft deal "failure premium" began to be factored into BP shares, the oil company's shares have fallen three times as much as the original Rosneft "lift." "Obviously it will be perceived negatively if this deal doesn't work out in the end and people will say BP didn't do its homework, but one thing everyone should realize is the fact that when the deal was announced BP stock didn't gain that much but once the deal ran into trouble BP stock came down a lot," Oppenheimer's Gheit said. At the same time, there's the short-term oil prices lift that BP has also not been afforded by the market. So is Rosneft a headline risk that has been overblown as far as it relates to the BP financial outlook? To answer this question requires both a short-term and long-term view of BP. The short-term view dictates that the Rosneft deal is a headline risk and headline risk only. "To discount today what earnings BP might gain from Arctic production ten years down the road is quite hypothetical," said Raymond James' Molchanov. "This doesn't mean much in terms of today's financial dynamics for BP, and it's not exactly an issue of management credibility, but it is allowing for criticism of management judgment," Molchanov said, adding, "for the record, my view is that managing the TNK-BP relationship is truly complicated." Argus Research's Weiss tends to the view that it is a headline issue that's been hyped beyond any observable financial metric, yet added, "This was the first big thing to come out of BP's Dudley-led management team since Macondo, and it seems like things that could have been covered upfront weren't." The only short-term risk that exists for BP investors is if BP were to cave in to demands from its partners in TNK-BP to get the Rosneft deal done, and any "opportunity cost" in losing the battle. The valuation that the partners have asked for has been widely ridiculed as grossly overvaluing the TNK-BP venture, and Dudley has publicly stated that BP has offered the partners a number of deals short of giving up BP shares, which would punish existing shareholders. Analysts also noted that in this case, the Kremlin is actually supporting BP, which wasn't the case when Dudley was forced to leave the country during his tenure as head of TNK-BP. Indeed, on Wednesday, Russian Prime Minister Vladimir Putin told reporters after his annual address to Russia's Parliament, "As for cooperation with such a respectable company as BP, we would welcome that both for TNK-BP and for Rosneft," according to a Reuters report. Reuters also quoted Putin as saying, "When the British colleagues came to us with their proposals on working with Rosneft, I said we would support this. At the time, no-one told me personally or Rosneft about any mutual obligations to TNK-BP. We simply did not know anything about this." "I don't think BP should give in and don't think they will," said the Raymond James analyst. "I think BP understands that as lucrative as a potential Arctic is, diluting shareholders today in return for something that could be ten years out in the future is rarely a smart move," the analyst added. Argus Research's Weiss said investors can't completely disregard the risk that BP makes a larger financial concession than currently advertised to assuage its partners and based on its level of desperation to get the deal done. Still, he thinks capitulating is not a likely end result. More importantly, the Rosneft fiasco does raise the critical long-term issue for BP since its asset sales began. The long-term view starts with the fact that a byproduct of BP's asset divestitures is a reduction of production in the range of 300,000 to 400,000 barrels of oil. The Rosneft deal was viewed as a future path to growth for BP, and the biggest issue any integrated oil company faces is access to resources. "They have to worry about where production is coming from not just today but out into the future, and if BP is unable to work out the deal, someone else steps in and this path is taken away," Weiss said. Indeed, ExxonMobil recently came to an agreement on additional work in Russia and has an existing agreement in the Sakhalin Island. At the last Davos World Economic Forum, Exxon Mobil CEO Rex Tillerson could be seen in a friendly embrace with a Russian government minister key in the energy business after the deal was struck. "Exxon is definitely a possibility," Weiss said. Oppenheimer's Gheit took issue with the idea that Dudley could be judged on the Rosneft outcome, saying it "absolutely was not the case" that there was any management credibility issue. "I visited him in Moscow five years ago when he ran TNK-BP and he knows the business well. This is a big company and all the big oil companies are looking for what will happen to the company five, ten, fifteen years from now. They have to plant the seeds now beyond Dudley's retirement, and it's the same for Exxon and Chevron," Gheit said. The analysts also noted that since the oil spill BP has won new leases in Angola, India -- through a joint venture with Reliance Industries -- and in Australia, all major oil producing countries that are offering BP offshore acreage less than year after Deepwater Horizon. The Oppenheimer analyst concluded, "Dudley needs to replace reserves, and the question is how soon and via what projects, but no project will give BP the 300,000 to 400,000 barrels of production they divested." "What I'll say is that Bob Dudley knows how Tony Hayward felt. It's a very different situation in substance, but as far as management trying to deal with the situation, it has a similar flavor in terms of level of complexity and sensitivity, including political sensitivity," Raymond James Molchanov concluded on the one-year anniversary of the oil spill.
Between the need to secure future production growth and comparisons between the current Rosneft deal and the BP oil spill media circus, there's the ultimate issue for BP: when will it get back to drilling in the Gulf of Mexico, where it is the largest leaseholder of all the Big Oil companies. Gulf of Mexico production for BP is in the range of 11%, and while that's the largest of the super majors, drilling on Gulf exploration projects, like the Rosneft opportunity, is part of a five-year production target at the earliest. "I still believe BP has the best position in the Gulf of Mexico, with the largest leases and best technology -- and, yes, they made incredible mistakes, but nevertheless they know the area well and are good at it. The U.S. needs BP and BP needs the U.S.," Oppenheimer's Gheit said with confidence. The cadre of long-term BP bulls aren't ready to offer a view of when BP gets back to work in the Gulf, but they contend that the single greatest risk to not getting back to work in the Gulf is the gross negligence claim that serves as an overhang on BP shares. From all recent indications, all three analysts were of the opinion that gross negligence, if not entirely off the table, is now a remote possibility. Argus Research's Weiss said recent comments by Michael Bromwich, the head of the government's new drilling watchdog, the Bureau of Ocean Energy Management & Research, seem to bolster the argument that BP is not a "serial" offender, and that while it has had issues on the refining side with the Texas City refinery fire, and in Alaska, as far as the Gulf of Mexico is concerned, the Macondo blowout is the only violation. Because the comments from Bromwich are political as opposed to legal, though, the analysts are more focused on the reports from the National Commission on the Deepwater Horizon Oil Spill and Offshore Drilling, and from the Marine Board of Investigation report, due out in late July. Raymond James's Molchanov said his firm is not assuming any gross negligence payment for BP, and the single biggest reason for that level of confidence is that the presidential commission report on the oil spill concluded that the broader safety culture within the industry and among regulators was essentially at fault. "The root causes are systemic and absent significant reform in industry practices and government policies, might well reoccur," the report said. "Had they wanted to blame BP exclusively they could have done so, and they didn't. That's a political conclusion, not a legal one. But if I were a BP attorney I would just quote that sentence in any legal setting and it should be a powerful argument," Molchanov concluded. "Gross negligence seems unlikely, especially given problems with the blowout preventer and the government having given approval for some of the things that happened. The likelihood of gross negligence is negligible," Argus Research's Weiss added.
The biggest catalyst for BP shares in terms of removing the gross negligence argument once and for all could come in late July when the Marine Board of Investigation releases its report. From a legal standpoint it is more important than the presidential commission, Oppenheimer's Gheit said, and will serve as a the basis for the Justice Department, state and local governments. The panel reviewed the blowout preventer specifically and has made it clear that it was not a maintenance problem or an operating problem, but an equipment failure caused by design. On the one-year anniversary of the oil spill, BP filed lawsuits against Cameron International, the maker of the blowout preventer, along with rig operator Transocean and deepwater engineer Halliburton. BP sued Transocean for $40 billion -- BP has so far written off $41 billion in oil spill charges -- citing failures in every single aspect of Transocean's Deepwater Horizon rig systems and devices. BP is suing Cameron International for faulty design in the blowout preventer, which echoes the comments from the government report on the device. BP had previously stated in its interim oil spill report that Halliburton's "bad cement job" was to blame, and now is suing Halliburton for fraud, negligence and concealing material facts in connection with its work on the rig. One important legal fact in the BP suits filed on the one-year anniversary of the oil spill is that BP's right to sue would have expired had it not filed within a year of the disaster. The Oppenheimer analyst noted that of the $41 billion written off by BP for the oil spill, the total amount it has paid, now above $20 billion, will likely keep increasing by another billion or two to account for cleanup costs which are running at $5 million per day, though down from $20 million a day in January. The biggest liability that BP faces is the penalty under the Clean Water Act, which at a low end will be roughly $4.5 billion, and, in the case of gross negligence, as high as $17 billion to $21 billion. Yet BP can't not be found gross negligent and its Macondo well partners Anadarko (25%) and Mitsui (10%) not be forced to pay some portion of the liabilities. "It's not if the partners pay; it's how much and when," Gheit said. Argus Research's Weiss has assumed from day one of the oil spill that at some point, Anadarko will have to take a charge for some portion of the liabilities. The Oppenheimer analyst is betting that BP will ultimately have a significantly lower liability than the $41 billion it has already written off. "The jury is still out, but so far most of the report has more or less helped BP's case, at least for not being grossly negligent," Gheit concluded. "The July report will be the basis for all litigation, and we will know better, not exactly to the last million, but will it be $5 billion or $20 billion more, and that's very important point for BP and an inflection point for BP shares," the Oppenheimer analyst predicted. Indeed, a catalyst is just what the range-bound BP shares need to finally pass the year-long slick on which they've skidded. -- Written by Eric Rosenbaum from New York.
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